Time to read : 6 Minutes
Inheritances are typically split equally between children (or grandchildren), but when it comes to getting financial help from parents… or the Bank of Mum and Dad (BoMaD), it isn’t so straightforward. Why? Because of questions around fairness.
As a financial adviser, I’m often asked whether it’s fair if one adult child receives financial support in advance – usually in the form of an early inheritance – when the others don’t get money (just yet).
While everyone’s situation is different, let’s take a look at ways to make this as fair as possible for everyone. But first, here are a few scenarios why one adult child may ask for an early hand out.
Why an adult child may ask a parent for money
Sydney retirees Lesley and George have two middle-aged daughters. Chelsea, their youngest, was unable to get a home loan following a messy divorce from her husband. She received $1 million from her divorce settlement but needed another $1 million to buy a house outright.
Chelsea turned to BoMaD and bought a $2 million home without a bank loan.
Gold Coast couple Julie and Mitchell are transitioning into retirement. Their eldest son Mark, who works in hospitality, was given the opportunity to buy the café that he manages. But Mark is a renter with limited savings.
Mark asked his parents for the $500,000 purchase price and bought the cafe.
Heather, a widow from Melbourne, relies on a part-pension to supplement her super. She has been regularly transferring money to her middle son, Sebastian, to help him pay off his credit card debt, as part of a mutually-agreed loan.
Sebastian needed $35,000 to cover the debt.
While these three scenarios sound different, essentially, they are the same. Parents are financially supporting one of their adult children. And that’s when the issue of fairness – from the other children – may creep in.
How to address issues of fairness
The answer isn’t simple and depends on a few factors. Let’s break it down.
Have an open conversation
The decision to provide financial assistance to one child can impact other family members, so being transparent is vital.
When everyone knows what’s happening, it means there are no issues or surprises down the track. Having an open discussion also gives an opportunity for siblings to air any concerns, so you can iron them out from the getgo.
Assess the circumstances
Just as all families are different, so are everyone’s circumstances and that could mean one sibling may need more help.
For instance, if Sebastian was living with disability, a chronic illness or was unemployed, it would make sense for Heather to help him pay off his credit card debt. His brothers on the other hand may be fully self-sufficient.
Yes, but… if all three sons were well-off, this could look more like favouritism towards Sebastian, so look at all factors carefully.
Decide if it will be a gift or a loan
One of the most important decisions to make, is whether the money will be a gift – you don’t expect it returned, or loan – the money is to be repaid.
This could boil down to the amount being asked. For example, Chelsea’s request for $1 million is more likely to be an early inheritance gift, whereas Sebastian’s $35,000 to pay off his debt is more likely to be a loan, as it could be slowly paid back.
Note: gifts potentially show unfair favouritism whereas loans, if repaid in full, should have no impact on the other siblings.
Where will the funds come from?
Not all parents will have the lump sum available, so would it be fair for parents to resort to:
selling shares to free up cash
redrawing from the home equity
taking out a reverse mortgage?
Be aware: if the equity in the home is reduced, it could impact the future inheritance of the other siblings. There could also be tax implications. Always talk to a financial professional to look at your specific situation before making a decision.
What about inflation or market growth?
Inflation reduces the value of money over time, so that means in the years to come the playing field is no longer level. Think of that 2 litre milk that cost $3 in 2022 – it now costs $5.
On top of the impacts of inflation, if you add market growth for property prices into the mix, then you could have more issues of fairness. Let’s say Chelsea’s property grows in value to $3 million by the time her parents pass away, this puts the net benefit from her parents at $1.5 million.
If her older sister receives the original $1 million as an inheritance, (which was the amount Chelsea received) she has missed out on the $500,000 capital growth. She would only have one-third of the purchase price of a similar home, whereas Chelsea received half.
Who benefits?
While one of the children will benefit from receiving the money, it could also benefit the parents too.
Let’s say if Lesley and George decided to downsize and move into the property Chelsea bought, they could be financially better off even though they have made a $1 million transfer to Chelsea.
They can also share expenses and Chelsea can avoid the single’s tax.
What about risks to the parents?
Fairness is one thing but there are some risks to the parents when parting with significant money:
Changing circumstances: if one parent suffers a serious illness and more money is suddenly needed for their healthcare, it could be an issue if money is no longer available. It’s always wise to have a buffer or a backup plan.
Living longer: it’s possible one or both parents may live longer than they had expected and budgeted for.
Defaulting on a loan: if an adult child doesn’t repay a loan or defaults on a loan that their parents had gone guarantor, it can potentially put their own home at risk.
Relationship breakdowns: the last thing you want is for the child who’s received the money to separate from their partner, with the ex walking away with half the money. A pre-nup or binding financial agreement can help protect finances.
5 tips for fairness for everyone
You want to be sure everyone in the family is treated as fairly as possible. Here’s what it comes down to:
Set ground rules
It’s really important to establish ground rules from the start. And one of the big ones is whether the money will be a gift or loan. If it’s a loan, you will need to agree on the repayment schedule, amounts, and if any interest will be paid.
Be aware: this should always be put in writing. Get a legal professional to draw up a contract and that way if any issues arise it’s clearly documented and easier to resolve.
Reduce risk
The last thing you want is for anything to go wrong. And while it’s not nice to think about, you should consider worst-case scenarios along with strategies for dealing with them. These can be a combination of emergency plans, legal agreements, and insurance.
Risk mitigation is a complex area so get some professional help to safeguard your future.
Consider matters relating to ownership
When parents provide money, questions around ownership may come up.
For example, will Mark’s parents have a financial stake in the cafe they helped him buy? Or in the case of Chelsea, if her parents suddenly needed the money they contributed, could she lose her home?
It’s important to work through the details and consider any special conditions that may apply, in case parents want to access the equity in the future.
Will and estate planning
Whatever the arrangements are, they should be outlined by both sides in wills and estate plans.
Parents can do this by:
deducting the amount provided
adjusting the percentage split of their estate
gifting the same amount to other children in the form of a trust.
Meanwhile, adult children who received money from parents can have their own wills drawn. They could name their parents as beneficiaries – in other words give the money back – or share it with their siblings.
Look at other contributions including non-financial
While one child needs a financial lump sum, others may benefit from different types of contributions from parents. It could be regular babysitting or childcare, ongoing payment of school fees, or joint holidays.
There are lots of options, you just need to think a little outside the box to find what works for you or your family.
Bottom line
Given the financial, legal, and future tax implications of intergenerational money transfers, it’s important that everyone gets their own professional advice.
That means a financial adviser, estate lawyer or accountant, plus any other relevant professionals such as a mortgage broker if buying a property.
The golden rule is: document everything. Having agreements and conditions in writing gives visibility for everyone, and helps address fairness, both now and in future.
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Disclaimer
The information in this article is of a general nature only and does not constitute personal financial or product advice. Any opinions or views expressed are those of the authors and do not represent those of people, institutions or organisations the owner may be associated with in a professional or personal capacity unless explicitly stated. Helen Baker is an authorised representative of BPW Partners Pty Ltd AFSL 548754.
